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Learning Objectives
• Understand the roles of financial management
and finance activities
Financial Management • Outline the financial planning process, and
explain 3 key budgets in the financial plan
• Explain why firms need operating funds
• Identify and describe different sources of short-
term financing
• Identify and describe different sources of long-
term financing
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What Is Finance? Financial Managers

• Financial managers
• Finance is a business function that acquires and
manages funds for the company – Examine financial data prepared by accountants
• Finance activities include – Recommend strategies for improving the financial
– Prepare budgets performance of the firm
– Do cash flow analysis – Are responsible for
– Plan for the expenditure of funds on assets (plant, • Paying company bills
equipment, machinery) • Collecting payments
• Financial management - Managing a firm’s • Staying abreast of market changes
resources to meet its goals and objectives • Assuring accounting accuracy
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What Financial Managers Do

Why Do Firms Fail Financially

• Undercapitalization (insufficient funds)
• Poor control over cash flow
• Inadequate expense control

Financial Planning
• Analyze short-term and long-term money flows
to and from the firm
• 3 steps
– Forecast the firm’s short-term and long-term
financial needs
– Develop budgets to meet these needs
– Establish financial controls to see if the company
achieve its goals


Financial Forecasting Budget Process

• A budget sets forth management’s
• Short-term forecast predicts revenues, costs, and
expectation for revenues based on which
expenses for a period of 1 year or less
allocates the use of specific resources
• Cash flow forecast predicts cash inflows and throughout the firm.
outflows in future periods, usually months or
quarters • A budget depends on the accuracy of balance
• Long-term forecast predicts revenues, costs and sheet, income statement, statement of cash
expenses for a period longer than 1 year, as long as flows and short-term and long-term financial
5 or 10 years forecasts
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Budget Types
Financial Control
• Capital budget highlights a firm’s spending • Financial control is a process in which a firm
plan for major asset purchases periodically compares its actual revenues,
• Cash budget estimates cash inflows and costs and expenses with its budget
outflows during a period, monthly or quarterly
• Operating (master) budget ties together other
budgets and summarizes its proposed
financial activities
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Why Firms Need Operating Funds?

• Is the firm meeting its short-term financial
commitments? • Manage day-by-day needs of the business
• Is the firm producing adequate operating profits • Control credit operation
on its assets? • Acquire needed inventory
• How is the firm financing its assets? • Make capital expenditures

• Are the firms owners receiving an acceptable

return on their investment?

Why Firms Need Funds

Sources of Funds
Short-Term Funds Long-Term Funds

Monthly expenses New-product development

• Debt financing
Unanticipated emergencies Replacement of capital equipment – Bank loan, bond
• Equity financing
Cash flow problems Mergers or acquisitions
– Sell ownership (stock)
Expansion of current inventory Expansion into new markets

Temporary promotional programs New facilities


Short-term Financing
• Funds needed for a year or less
• Sources
– Trade credit
– Family and friends
– Commercial banks
– Commercial finance companies

Short-term Financing
Long-term Financing
• Commercial bank offers • Funds needed for more than a year
– Secured loan • 2 types
– Unsecured loan – Debt
– Line of credit – Equity
– Revolving credit agreement

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Debt Financing
• Bond is a corporate certificate indicating that
• Company borrows money and has a legal
an investor has lent money to a firm (a
obligation to repay
• 2 sources
• The principal is the face value of a bond and is
– Loan repaid to bondholders on maturity date
– Bond • Interest is made annually to bondholders, at
the specified rate
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• Advantages for issuing organization
– Bondholders can’t vote on corporate matters • Drawbacks of issuing bonds
– Bond interest is tax-deductible – Bonds increase debt (long-term liabilities)
– Debt obligation can be eliminated when the – Paying interest on bonds is a legal obligation
firm repays fully – Payment obligation may cause cash flow
– Bonds can be repaid before the maturity date problem when repayment comes due
with a call provision

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Equity Financing
• The firm sells shares of ownership (stock) to
• Advantages for issuing firm
outside investors
– The firm never has to repay stockholders’
– Stockholders are owners of the firm
• The firm keeps and reinvests its profits – No legal obligation to pay dividends, the firm
(retained earnings) can reinvest income (retained earnings)
• A start-up business receives venture capital – Issuing stocks creates no debt
from investors
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Debt vs. Equity

Stocks Conditions Debt Equity

None. Unless special Common stock
conditions have been holders have voting
• Disadvantages influence
agreed on. rights.
– Stockholders have the right to vote for the Debt has a maturity Stock has no maturity
company’s board of directors date. date.

– Dividends are not tax-deductible The firm isn’t legally

Yearly obligations Payment of interest. liable to pay
– Managerial decision is affected by the need to dividends.
keep stockholders happy
Interest is tax Dividends are not tax
Tax benefits
deductible. deductible.